Barron's Explores The Hidden Risks Of Exchange-Traded Funds

In this week's
Barron's cover story, Jonathan Laing explores some of the
hidden risks of exchange-traded funds, or ETFs.

ETFs are securities that trade on an exchange, like a stock, and
are designed to track the performance of a certain index or
sector of the market. One of the most popular ETFs, for example,
is the SPDR S&P 500 ETF, which trades under the ticker symbol
'SPY' and seeks to track the performance of the S&P 500.

A primary concern Laing addresses is how ETFs will act during a
market downturn, writing that: "For all their popularity and
éclat, exchange-traded funds are like blockbuster drugs — hugely
beneficial when used correctly, but not bereft of potential
adverse side effects."

Laing cites Rick Ferri, who uses ETFs in his money management
business and has written extensively about these instruments, who
said ETFs "performed admirably" during the financial crisis. He
added, however, that the industry is now three times larger.

Ferri said that ETFs now cover "so many more illiquid asset
classes that investors could suffer adverse consequences in the
next major market down that we don't know of yet."

And as the industry has grown, ETFs risk becoming more important
the indexes they represent.

Laing:

[Mark Wiedman, head of BlackRock's iShares] really turned heads
when he asserted in a June 29, 2013, letter to iShares
fund-holders that 'more and more, ETFs — rather than the
underlying indexes that are supposed to drive them — 'are
becoming the true market.' In other words, if investor fears
cause the market for bonds or some other asset effectively to
freeze up, ETFs may well be the only thing left trading. In such
cases, the ETF in a very real sense 'becomes' the market. Is that
desirable, or even advisable? Probably not: That 'cure' is worse
than the disease.

To avoid the financial peril that can come with getting stuck in
a ETF vulnerable to large market swings, Laing writes that
investors should stick to ETFs "representing broad, liquid parts
of the market and offered by reputable companies."

EMC Shares Have Upside

Also in Barron's this week,
Lawrence Strauss takes a look at data-storage company EMC,
which has seen shares underperform in recent years, though the
stock has recently come to life.Darren McCollester/Getty
Images

Strauss notes that Elliott Management, the hedge fund led by
Paul Singer, has taken a 2% stake in EMC and is urging
the company to spin off data-center software company VMware.

EMC owns 80% of VMware, which is now almost as large as EMC with
a market cap of $43 billion compared with EMC's $60 billion,
Strauss writes.

"Even if VMware isn't spun off — and there's a good chance that
it won't be, at least in the short term — EMC should do fine with
its federation structure, though it could take longer for the
stock to move," Strauss writes. "So, regardless of what course
EMC chooses, its stock should come out from under the cloud
that's been hovering over it."